Yesterday is history, tomorrow is a mystery: Directors’ and CEOs’ prior bankruptcy experiences and the financial risk of their current firms

Abstract

Using a large sample of Swedish private firms, we investigate the link between the prior corporate bankruptcy experiences (BEs) of directors and CEOs and the financial risk of their current firms. We find that firms with directors and CEOs previously involved in bankruptcies exhibit more aggressive corporate financial policies, have a higher corporate bankruptcy risk and are subject to a higher cost of debt. Our findings align with an innate characteristics explanation: corporate BEs and current corporate risk-taking reflect personal risk preferences. Furthermore, while we find evidence of income losses for CEOs and directors involved in bankruptcies, such losses are transient, potentially explaining the risk-taking behavior after experiencing bankruptcy. Overall, our results suggest that the presence of individuals with prior BE can be considered a signal of higher financial risk for their firms. This insight is relevant to regulators, lenders and corporate decision-makers.